Process Costing

Meaning❑Process costing is a method of operation costing which is used to ascertain thecost of production at each process, operation or stage of manufacture, whereprocesses are carried in having one or more of the following features:

❑Where the product of one process becomes the material of another process oroperation

❑Where there is simultaneous production at one or more process of differentproducts, with or without by product,

❑Where, during one or more processes or operations of a series, the products or materials are not distinguishable from one another, as for instance when finished products differ finally only in shape or form.

❑Process costing is defined by Kohler as: “A method of accounting whereby costs are charged to processes or operations and averaged over units produced; it is employed principally where a finished product is the result of a more or less continuous operation, as in paper mills, refineries, canneries and chemical plants; distinguished from job costing, where costs are assigned to specific orders, lots or units.

Characteristics❑Process Costing Method is applicable where the output results from acontinuous or repetitive operations or processes.

❑Products are identical and cannot be segregated.

❑It enables the ascertainment of cost of the product at each process or stage ofmanufacture.

❑The output consists of products, which are homogenous.

❑Production is carried on in different stages (each of which is called a process)having a continuous flow.

❑The input will pass through two or more processes before it takes the shape ofthe output. The output of each process becomes the input for the next processuntil the final product is obtained, with the last process giving the final product.

❑The output of a process except the last may also be saleable in which case theprocess may generate some profit.

❑The input of a process except the first may be capable of being acquired fromthe outside sources.

❑The output of a process is transferred to the next process generally at cost to theprocess. It may also be transferred at market price to enable checking efficiencyof operations in comparison to the market conditions.

❑Normal and abnormal losses may arise in the processes.

Advantages

❑It is possible to determine process costs periodically at short intervals. Average unit cost can be computed weekly or even daily.

❑It is simple and less expensive to find out the process costs.

❑It is possible to have managerial control by evaluating the performance of each process.

❑It is easy to allocate the expenses to processes in order to have accurate costs.

❑It is easy to quote the prices with standardization of process. Standard costing can be established easily in process type of manufacture.

Disadvantages of Process Costing❑Cost obtained at the end of the accounting period are only of historical value and are not very useful for effective control.

❑Valuation of work-in-progress is generally done of estimated basis which introduces further inaccuracies in total cost.

❑Where different products arise in the same process, it is not possible to exactly ascertain the total cost of the products.

❑If any error occurs while calculating average costs, it will be carried through all the processes to the valuation of work in process and finished goods.

❑The computation of average cost is more difficult in those cases where more than one type of product is manufactured and a division of the cost element is necessary.

Difference between Process and Job Costing

Basis for Comparison Job Costing Process Costing

Meaning

Job costing refers to calculating the cost of a special contract, work order where work is performed as per client's or customer's instructions.

A costing method, in which the costs which are charged to various processes and operations is ascertained, is known as Process Costing.

Nature Customized production Standardized production

Assignment of costCalculating cost of each job.

First of all, cost is determined for the process, thereafter spread over the produced units.

Cost Center Job Process

Scope of cost reduction Less High

Transfer of Cost No transferCost is transferred from one process to another

IdentityEach job is different from another.

Products are manufactured consecutively and so they lose their identity.

Basis for Comparison Job Costing Process Costing

Cost Ascertainment Completion of the job. End of the cost period.

Industry type

Job costing is suitable for the industries which manufactures products as per customer's order

Process costing is perfect for the industry where mass production is done.

LossesLosses are usually not segregated.

Normal losses are carefully ascertained and abnormal losses are bifurcated.

Work-in-progress (WIP)WIP may or may not exist at the beginning or at the end of the financial year.

WIP will always be present in the beginning or at the end of the accounting period.

Practical The manufacture of product “Fanta” requires three distinct processes. Oncompletion of the product is passed from Process 3 to finished stock. Duringthe month of December 1992, the following information was obtained:

Production Overhead is absorbed by processes at a percentage of direct wages.

Production during the period was 1,000 kgs. There was no stock of raw materials

or work-in-progress at the beginning or at the end of the month.

Losses in Process

Normal Loss: The fundamental principle of costing is that the goodunits should bear the amount of normal loss. Normal loss isanticipated and in a process it is inevitable. It is included in total costof the product due to which cost per unit is increases. The cost ofnormal loss is therefore not worked out. The number of units ofnormal loss is credited to the Process Account and if they have somescrap value or realizable value the amount is also credited to theprocess account. If there is no scrap value or realizable value, onlythe units are credited to the process account.

Abnormal Loss: If the units lost in the production process are more than thenormal loss, the difference between the two is the abnormal loss. It is excludedfrom total cost due to which it does not affect the cost per unit of the product.The relevant process of account is credited and abnormal loss account isdebited with the abnormal loss valued at full cost of finished output. Theamount realized from sale of scrap of abnormal loss units is credited to theabnormal loss account and the balance in the abnormal loss account istransferred to the Costing Profit and Loss Account.

Abnormal Gain: If the actual production units are more than the anticipatedunits after deducting the normal loss, the difference between the two is known asabnormal gain. It is excluded from total cost due to which it does not affect thecost per unit of the product. The valuation of abnormal gain is done in the samemanner like that of the abnormal loss. The units and the amount is debited to therelevant Process Account and credited to the Abnormal Gain Account.

Treatment of Normal Loss❑The cost of normal loss is considered as part of the cost of production in whichit occurs. If normal loss units have any realizable scrap value, the processaccount is credited by that amount. If there is no abnormal gain, then there is nonecessity to maintain a separate account for normal loss.

❑Generally the cost of normal loss is absorbed by the cost units.

Normal Output = Units introduced – Units of normal loss

Normal Cost of Normal Output = Total Cost – Scrap value of Normal Loss.

❑In process A/c units of normal wastage is shown in unit column of credit sideand if there is any scrap value then that will be shown in amount column of thecredit side corresponding to lost units.

Treatment of Abnormal LossAbnormal loss is transferred directly to P/L Account.

Value of Abnormal wastage =

Normal cost of normal output/Normal output * Units of abnormalWastage

Here,

Normal Cost of Normal Output = Total Cost – Scrap value of NormalLoss.

Units of abnormal Wastage = Normal Output – Actual Output

Normal output = Units introduced – Units of normal loss

Practical Problem – Abnormal LossThe Bharat Manufacturing Company’s product passes through two distinct processes, X and Y, and then to the finished stock. It is known from the past experience that wastage occurs in the process as under:

In Process X, 5% of the units entering the process.

In Process Y, 10% of the units entering the process.

The scrap value of the wastages in process X is Rs.8 per 100 units and in process Y is Rs.10 per 100 units.

Treatment of Abnormal GainWhen Actual output is more than the normal output.

Value of Abnormal Gain =

Normal cost of normal output/Normal output* Units of Abnormal Effectives(Gains)

Here,

Units of Abnormal Effectives(Gains) = Units entered – Normal Wastage –Actual output.

Questions

VALUATION OF WORK-IN-PROGRESS❑Since production is continuous, there may be some units which are notfinished at the end of an accounting period.

❑Such incomplete production units are known as Work-in-Progress. SuchWork-in-Progress is valued in terms of equivalent or effective productionunits.

❑To show production process completely, we have to convert incompleteunits into equivalent units.

Equivalent units of work in progress = Actual no. of units in progress xPercentage of work completed

Equivalent unit should be calculated separately for each element of cost(viz. material, labour and overheads) because the percentage ofcompletion of the different cost component may be different.

The following procedure is followed when there is Work-in- Progress

(1) Find out equivalent production after considering, degree ofcompletion of opening and / or closing stock.

(2) Find out net process cost according to elements of costs i.e. material,labour and overheads.

(3) Ascertain cost per unit of equivalent production of each element ofcost separately by dividing each element of costs by respectiveequivalent production units.

(4) Evaluate the cost of output finished and transferred work in progress

Three statements are prepared:

❑ Statement of equivalent Production.

❑ Statement of Cost (per unit)

❑Statement of evaluation.

And process account is to be made.

Normal Loss- equivalent units of normal loss are taken as nil. Normalloss is not added in the equivalent production. However, realisable valueis deducted from the cost of material, this will give net material cost.

Abnormal Loss- Abnormal loss is added to equivalent production afterconsidering the degree of completion specified, it may be assumedabnormal units are 100% complete.

Abnormal Gain – To obtain equivalent units, abnormal gain isdeducted. Abnormal gain taken as 100% complete in respect of allelements of cost.

❑When there is opening and closing stock of Work- in-Progress in the questions, to calculate equivalent production two methods can be used:

❑FIFO method

❑Average Cost Method

To practice on the above topic, questions from MN Arora and Maheshwari Mittal can be done.

BY-PRODUCTS AND JOINT PRODUCTS

❑By-products are defined as “any saleable or usable value incidentally producedin addition to the main product”. By-products means secondary or subsidiaryproducts arising in the course of manufacturing the main product(s).

❑For example, in oil refinery crude oil is processed but by-products, i.e. bitumen,chemical fertilizer are obtained with the main product-refined oil. Similarly incoke ovens, gas and tar are incidentally produced in addition to the main productcoke. Gas and tar are therefore treated as by-products.

Methods of Apportionment of Joint Cost over joint products:

❑ Sales Value Method

❑Reverse Cost Method

❑Physical Units Method

❑Average Unit Cost Method

❑Survey Method